The Question

Nike's report P107-111

An example from Week 4's lecture

RIV valuation for Nike In this Weekly Assignment, you are asked to apply the residual income valuation (RIV) model to calculate the intrinsic price of Nike. On Canvas you can find the annual report by Nike for year-end May 31, 2015. In pages 107- 11 you can find the consolidated financial statements for 2014 and 2015. In addition, you are provided the following information and assumptions: Nike's cost of equity capital is 10%. As at May 31, 2015, Nike had 855,351,589 common shares outstanding. The share price Nike as at May 31, 2015 was $50.94. From 2016 to 2020, Nike's earning per share is expected to grow at 6% on average per annum. The Net Dividend Payout ratio (i.e. net dividend paid to shareholders relative to income earned), is projected to be at 0.27 per annum on average from 2016 onwards. Assume 1% terminal growth in abnormal earnings. Assume 1% terminal growth in abnormal earnings. Required: You are required to develop an Excel spreadsheet, similar to those provided in Week 4 reading material that would: 1) Calculate the intrinsic equity price of Nike as at year-end 2015 using the residual income valuation (RIV) model and the information provided above. 2) Calculate by hand the implied terminal growth of abnormal earnings for Nike as at 2015, assuming that all other assumptions are correct. Note that this calculation must be done by hand and show the manual calculation steps in the Word report. Then, in no more than 100 words, explain how you can use this knowledge of the implied growth rate for investment decision-making. 3) Using the Goal Seek tool in Excel to calculate the implied expected rate of return, assuming that all other input including the 1% growth in abnormal earnings are correct. Report this calculation in the Word report. Then, in no more than 100 words, explain how you can use this knowledge of the implied expected rate of return for investment decision- making. 4) In no more than 200 words, describe the appropriateness and the limitations of the RIV model and the assumptions employed in this valuation exercise, specifically within the context of Nike Ltd. We will not accept generic arguments. Provide arguments that are specifically relevant to Nike Ltd. You are required to submit an Excel spreadsheet that will contain the answer to the valuation exercise 1), plus a Word report with the answers to the exercises 2), 3) and 4). 106 PART II NIKE, Inc. Consolidated Statements of Income Year Ended May 31, 2014 2015 2013 30,601 $ 16,534 14,067 3,213 6,679 9,892 (In millions, except per share data) Income from continuing operations: Revenues Cost of sales Gross profit Demand creation expense Operating overhead expense Total selling and administrative expense Interest expense (income), net (Notes 6, 7 and 8) Other (income) expense, net (Note 17) Income before income taxes Income tax expense (Note 9) NET INCOME FROM CONTINUING OPERATIONS NET INCOME FROM DISCONTINUED OPERATIONS NET INCOME NET INCOME Earnings per common share from continuing operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Earnings per common share from discontinued operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Dividends declared per common share 27,799 $ 15,353 12,446 3,031 5,735 8,766 33 103 3,544 851 2,693 28 (58) 4,205 932 3,273 25,313 14.279 11,034 2,745 5,051 7,796 (3) (15) 3,256 805 2,451 21 2,472 $ 3,273 $ 2,693 S $ $ 3.80 $ 3.70 $ 3.05 S 2.97 $ 2.74 2.68 $ $ $ 1.08 $ $ $ 0.93 $ 0.02 0.02 0.81 FORM 10-K The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. NIKE, INC. 2015 Annual Report and Notice of Annual Meeting 107 PART II NIKE, Inc. Consolidated Statements of Comprehensive Income Year Ended May 31, 2015 2014 3,273 $ 2,693 $ 2013 2,472 $ in millions) Net income Other comprehensive income (loss), net of tax: Change in net foreign currency translation adjustment) Change in net gains (losses) on cash flow hedges(2) Change in net gains (losses) on others) Change in release of cumulative translation loss related to Umbro) Total other comprehensive income (oss), net of tax TOTAL COMPREHENSIVE INCOME (20) 1,188 (32) (161) 4 38 12 (8) 83 125 2,597 1,161 4,434 $ (189) 2,504 $ (1) Net of tax benefit (expense) of $0 million, $0 million and $(13) milion, respectively. (2) Net of tax benefit (expense) of $(31) million, $18 million and $22) million, respectively. (3) Net of tax benefit (expense) of $0 milion, $0 million and $1 milion, respectively. (4) Net of tax benefit (expense) of $0 million, $0 million and $47 million, respectively. The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. 108 PART II NIKE, Inc. Consolidated Balance Sheets May 31, 2015 2014 $ 3,852 $ 2,072 3,358 4,337 389 000 1,968 15,976 3,011 281 131 2,201 21,600 $ 2.220 2,922 3,434 3,947 355 818 010 13,696 2,834 282 282 131 1,651 18,594 S $ (In millions) ASSETS Current assets: Cash and equivalents (Note 6) Short-term investments (Note 6) Accounts receivable, net (Note 1) Inventories (Notes 1 and 2) Deferred income taxes (Note 9) Prepaid expenses and other current assets (Notes 6 and 17) Total current assets Total current assets Property, plant and equipment, net (Note 3) Identifiable intangible assets, net (Note 4) Goodwill (Note 4) Deferred income taxes and other asseta (Notes 6, 9 and 17) TOTAL ASSETS mu LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt (Note 8) Notes payable (Note 7) Accounts payable (Note 7) Accrued liabilities (Notes 5, 6 and 17) Income taxes payable (Note 9) Total current liabilities Long-term debt (Note 8) Deferred income taxes and other liabilities (Notes 6, 9, 13 and 17) Commitments and contingencies (Note 16) Redeemable preferred stock (Note 10) Shareholders' equity: Common stock at stated value (Note 11): on a state Class A convertible 178 and 178 shares outstanding Class B - 679 and 692 shares outstanding Capital in excess of stated value Accumulated other comprehensive income (Note 14) Retained earnings Total shareholders' equity TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 107 S 74 2,131 3,951 71 6,334 1,079 1,480 7 167 1,930 2,491 432 5.027 1,199 1,544 FORM 10-K 3 6,773 1,246 4,685 12,707 21,600 $ 3 5,865 85 4,871 10,824 18,594 $ The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. NIKE, INC. 2015 Annual Report and Notice of Annual Meeting 109 PART II NIKE, Inc. Consolidated Statements of Cash Flows Year Ended May 31, 2014 2015 2013 $ 3,273 $ 2,693 $ 2,472 606 (113) 191 43 424 518 (11) 177 68 56 438 20 174 64 66 (124) - (216) (621) (144) 1,237 4,680 (298) (505) (210) 525 3,013 142 (219) (28) 27 3,032 (5,386) 3,932 1.126 (4,133) 1,663 1,330 (4,936) 3,655 2,216 (150) (963) 3 (880) 3 (598) 14 786 in millions) Cash provided by operations: Net income Income charges (credits) not affecting cash: Depreciation Deferred income taxes Stock-based compensation (Note 11) Amortization and other Net foreign currency adjustments Net gain on divestitures Changes in certain working capital components and other assets and liabilities: (Increase) decrease in accounts receivable (Increase) in inventories Increase) in prepaid expenses and other current assets Increase in accounts payable, accrued liabilities and income taxes payable Cash provided by operations Cash used by investing activities: Purchases of short-term investments Maturities of short-term investments Sales of short-term investments Investments in reverse repurchase agreements Additions to property, plant and equipment Disposals of property, plant and equipment Proceeds from divestitures (Increase) in other assets, net of other liabilities Cash used by investing activities Cash used by financing activities: Net proceeds from long-term debt issuance Long-term debt payments, including current portion Decrease) increase in notes payable Payments on capital lease obligations Proceeds from exercise of stock options and other stock issuances Excess tax benefits from share-based payment arrangements Repurchase of common stock Dividends - common and preferred Cash used by financing activities Effect of exchange rate changes on cash and equivalents Net increase (decrease) in cash and equivalents Cash and equivalents, beginning of year CASH AND EQUIVALENTS, END OF YEAR Supplemental disclosure of cash flow information: Cash paid during the year for: Interest, net of capitalized interest Income taxes Non-cash additions to property, plant and equipment Dividends declared and not paid The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. (2) (1,207) (175) (940) 986 (49) 10 (63) (19) 514 218 (2,534) (899) (2,790) (83) 1,632 2,220 3,852 $ (60) 75 (17) 383 132 (2,628) (799) (2.914) 313 72 (1.674) (703) (1.045) 36 1,083 2,254 3,337 (1,117) 3,337 2,220 $ $ $ 53 $ 1,262 206 240 53 $ 856 167 209 20 702 137 188 110 PART 11 NIKE, Inc. Consolidated Statements of Shareholders' Equity (12) Common Stock Capital in Accumulated Excess Class A Class B Other of Stated Comprehensive Retained (In millions, except per share data) Shares Amount Shares Amount Value Income Earnings Total Balance at May 31, 2012 180 $ 736 $ 3 $ 4,641 $ 149 $ 5,526 $ 10,319 Stock options exercised 10 322 322 Conversion to Class B Common Stock (2) 2 Repurchase of Class B Common Stock (34) (10) (1,647) (1,657) Dividends on common stock (S0.81 per share) (727) (727) Issuance of shares to employees 2 65 65 Stock-based compensation (Note 11) 174 174 Forfeiture of shares from employees (8) Net income 2,472 2,472 Other comprehensive income (loss) 125 125 Balance at May 31, 2013 178 $ 716 $ 3 $ 5,184 $ 274 $ 5,620 $ 11,081 Stock options exercised 11 445 445 Repurchase of Class B Common Stock (37) (11) (2,617) 2,628) Dividends on common stock ($0.93 per share) (821) (821) Issuance of shares to employees 2 78 78 Stock-based compensation (Note 11) 177 177 Forfeiture of shares from employees (8) (4) (12) Net Income 2,693 2,693 Other comprehensive income (loss) (189) (189) Balance at May 31, 2014 178 $ 692 $ 3 $ 5,865 $ 85 $ 4,871 $ 10,824 Stock options exercised 14 639 639 Repurchase of Class B Common Stock (29) 19) (2.525) (2.534) Dividends on common stock ($1.08 per share) (931) (931) Issuance of shares to employees 2 92 92 Stock-based compensation (Note 11) 191 191 Forfeiture of shares from employees (5) (3) (8 Net Income 3,273 3.273 Other comprehensive income (loss) 1,161 1,161 Balance at May 31, 2015 178 $ 679 s 3 $ 6,773 $ 1,246 $ 4,685 $ 12,707 The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement FORM 10-K ) RIV numerical example with a constant growth rate Forecast years t=0 2001 2002 2003 2004 2005 EPS DPS 4.57 0.82 20.25 4.60 0.85 23.99 4.71 0.88 27.83 4.90 0.91 31.82 5.03 0.93 35.93 BPS 16.5 CV 1.91 2.92 0.9091 2.66 2.57 0.8264 2.12 2.31 0.7513 1.74 2.12 0.6830 1.45 1.85 0.6209 1.15 Residual Earnings Discount Factor PV of RE g=0.03 r=0.10. Opening BPS 16.50 Finite horizon RE 9.12 Continuing value 16.91 Inrtinsic Price 42.53 N.B. The XL Spreadsheet is on BB RIV valuation for Nike In this Weekly Assignment, you are asked to apply the residual income valuation (RIV) model to calculate the intrinsic price of Nike. On Canvas you can find the annual report by Nike for year-end May 31, 2015. In pages 107- 11 you can find the consolidated financial statements for 2014 and 2015. In addition, you are provided the following information and assumptions: Nike's cost of equity capital is 10%. As at May 31, 2015, Nike had 855,351,589 common shares outstanding. The share price Nike as at May 31, 2015 was $50.94. From 2016 to 2020, Nike's earning per share is expected to grow at 6% on average per annum. The Net Dividend Payout ratio (i.e. net dividend paid to shareholders relative to income earned), is projected to be at 0.27 per annum on average from 2016 onwards. Assume 1% terminal growth in abnormal earnings. Assume 1% terminal growth in abnormal earnings. Required: You are required to develop an Excel spreadsheet, similar to those provided in Week 4 reading material that would: 1) Calculate the intrinsic equity price of Nike as at year-end 2015 using the residual income valuation (RIV) model and the information provided above. 2) Calculate by hand the implied terminal growth of abnormal earnings for Nike as at 2015, assuming that all other assumptions are correct. Note that this calculation must be done by hand and show the manual calculation steps in the Word report. Then, in no more than 100 words, explain how you can use this knowledge of the implied growth rate for investment decision-making. 3) Using the Goal Seek tool in Excel to calculate the implied expected rate of return, assuming that all other input including the 1% growth in abnormal earnings are correct. Report this calculation in the Word report. Then, in no more than 100 words, explain how you can use this knowledge of the implied expected rate of return for investment decision- making. 4) In no more than 200 words, describe the appropriateness and the limitations of the RIV model and the assumptions employed in this valuation exercise, specifically within the context of Nike Ltd. We will not accept generic arguments. Provide arguments that are specifically relevant to Nike Ltd. You are required to submit an Excel spreadsheet that will contain the answer to the valuation exercise 1), plus a Word report with the answers to the exercises 2), 3) and 4). 106 PART II NIKE, Inc. Consolidated Statements of Income Year Ended May 31, 2014 2015 2013 30,601 $ 16,534 14,067 3,213 6,679 9,892 (In millions, except per share data) Income from continuing operations: Revenues Cost of sales Gross profit Demand creation expense Operating overhead expense Total selling and administrative expense Interest expense (income), net (Notes 6, 7 and 8) Other (income) expense, net (Note 17) Income before income taxes Income tax expense (Note 9) NET INCOME FROM CONTINUING OPERATIONS NET INCOME FROM DISCONTINUED OPERATIONS NET INCOME NET INCOME Earnings per common share from continuing operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Earnings per common share from discontinued operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Dividends declared per common share 27,799 $ 15,353 12,446 3,031 5,735 8,766 33 103 3,544 851 2,693 28 (58) 4,205 932 3,273 25,313 14.279 11,034 2,745 5,051 7,796 (3) (15) 3,256 805 2,451 21 2,472 $ 3,273 $ 2,693 S $ $ 3.80 $ 3.70 $ 3.05 S 2.97 $ 2.74 2.68 $ $ $ 1.08 $ $ $ 0.93 $ 0.02 0.02 0.81 FORM 10-K The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. NIKE, INC. 2015 Annual Report and Notice of Annual Meeting 107 PART II NIKE, Inc. Consolidated Statements of Comprehensive Income Year Ended May 31, 2015 2014 3,273 $ 2,693 $ 2013 2,472 $ in millions) Net income Other comprehensive income (loss), net of tax: Change in net foreign currency translation adjustment) Change in net gains (losses) on cash flow hedges(2) Change in net gains (losses) on others) Change in release of cumulative translation loss related to Umbro) Total other comprehensive income (oss), net of tax TOTAL COMPREHENSIVE INCOME (20) 1,188 (32) (161) 4 38 12 (8) 83 125 2,597 1,161 4,434 $ (189) 2,504 $ (1) Net of tax benefit (expense) of $0 million, $0 million and $(13) milion, respectively. (2) Net of tax benefit (expense) of $(31) million, $18 million and $22) million, respectively. (3) Net of tax benefit (expense) of $0 milion, $0 million and $1 milion, respectively. (4) Net of tax benefit (expense) of $0 million, $0 million and $47 million, respectively. The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. 108 PART II NIKE, Inc. Consolidated Balance Sheets May 31, 2015 2014 $ 3,852 $ 2,072 3,358 4,337 389 000 1,968 15,976 3,011 281 131 2,201 21,600 $ 2.220 2,922 3,434 3,947 355 818 010 13,696 2,834 282 282 131 1,651 18,594 S $ (In millions) ASSETS Current assets: Cash and equivalents (Note 6) Short-term investments (Note 6) Accounts receivable, net (Note 1) Inventories (Notes 1 and 2) Deferred income taxes (Note 9) Prepaid expenses and other current assets (Notes 6 and 17) Total current assets Total current assets Property, plant and equipment, net (Note 3) Identifiable intangible assets, net (Note 4) Goodwill (Note 4) Deferred income taxes and other asseta (Notes 6, 9 and 17) TOTAL ASSETS mu LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt (Note 8) Notes payable (Note 7) Accounts payable (Note 7) Accrued liabilities (Notes 5, 6 and 17) Income taxes payable (Note 9) Total current liabilities Long-term debt (Note 8) Deferred income taxes and other liabilities (Notes 6, 9, 13 and 17) Commitments and contingencies (Note 16) Redeemable preferred stock (Note 10) Shareholders' equity: Common stock at stated value (Note 11): on a state Class A convertible 178 and 178 shares outstanding Class B - 679 and 692 shares outstanding Capital in excess of stated value Accumulated other comprehensive income (Note 14) Retained earnings Total shareholders' equity TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 107 S 74 2,131 3,951 71 6,334 1,079 1,480 7 167 1,930 2,491 432 5.027 1,199 1,544 FORM 10-K 3 6,773 1,246 4,685 12,707 21,600 $ 3 5,865 85 4,871 10,824 18,594 $ The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. NIKE, INC. 2015 Annual Report and Notice of Annual Meeting 109 PART II NIKE, Inc. Consolidated Statements of Cash Flows Year Ended May 31, 2014 2015 2013 $ 3,273 $ 2,693 $ 2,472 606 (113) 191 43 424 518 (11) 177 68 56 438 20 174 64 66 (124) - (216) (621) (144) 1,237 4,680 (298) (505) (210) 525 3,013 142 (219) (28) 27 3,032 (5,386) 3,932 1.126 (4,133) 1,663 1,330 (4,936) 3,655 2,216 (150) (963) 3 (880) 3 (598) 14 786 in millions) Cash provided by operations: Net income Income charges (credits) not affecting cash: Depreciation Deferred income taxes Stock-based compensation (Note 11) Amortization and other Net foreign currency adjustments Net gain on divestitures Changes in certain working capital components and other assets and liabilities: (Increase) decrease in accounts receivable (Increase) in inventories Increase) in prepaid expenses and other current assets Increase in accounts payable, accrued liabilities and income taxes payable Cash provided by operations Cash used by investing activities: Purchases of short-term investments Maturities of short-term investments Sales of short-term investments Investments in reverse repurchase agreements Additions to property, plant and equipment Disposals of property, plant and equipment Proceeds from divestitures (Increase) in other assets, net of other liabilities Cash used by investing activities Cash used by financing activities: Net proceeds from long-term debt issuance Long-term debt payments, including current portion Decrease) increase in notes payable Payments on capital lease obligations Proceeds from exercise of stock options and other stock issuances Excess tax benefits from share-based payment arrangements Repurchase of common stock Dividends - common and preferred Cash used by financing activities Effect of exchange rate changes on cash and equivalents Net increase (decrease) in cash and equivalents Cash and equivalents, beginning of year CASH AND EQUIVALENTS, END OF YEAR Supplemental disclosure of cash flow information: Cash paid during the year for: Interest, net of capitalized interest Income taxes Non-cash additions to property, plant and equipment Dividends declared and not paid The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement. (2) (1,207) (175) (940) 986 (49) 10 (63) (19) 514 218 (2,534) (899) (2,790) (83) 1,632 2,220 3,852 $ (60) 75 (17) 383 132 (2,628) (799) (2.914) 313 72 (1.674) (703) (1.045) 36 1,083 2,254 3,337 (1,117) 3,337 2,220 $ $ $ 53 $ 1,262 206 240 53 $ 856 167 209 20 702 137 188 110 PART 11 NIKE, Inc. Consolidated Statements of Shareholders' Equity (12) Common Stock Capital in Accumulated Excess Class A Class B Other of Stated Comprehensive Retained (In millions, except per share data) Shares Amount Shares Amount Value Income Earnings Total Balance at May 31, 2012 180 $ 736 $ 3 $ 4,641 $ 149 $ 5,526 $ 10,319 Stock options exercised 10 322 322 Conversion to Class B Common Stock (2) 2 Repurchase of Class B Common Stock (34) (10) (1,647) (1,657) Dividends on common stock (S0.81 per share) (727) (727) Issuance of shares to employees 2 65 65 Stock-based compensation (Note 11) 174 174 Forfeiture of shares from employees (8) Net income 2,472 2,472 Other comprehensive income (loss) 125 125 Balance at May 31, 2013 178 $ 716 $ 3 $ 5,184 $ 274 $ 5,620 $ 11,081 Stock options exercised 11 445 445 Repurchase of Class B Common Stock (37) (11) (2,617) 2,628) Dividends on common stock ($0.93 per share) (821) (821) Issuance of shares to employees 2 78 78 Stock-based compensation (Note 11) 177 177 Forfeiture of shares from employees (8) (4) (12) Net Income 2,693 2,693 Other comprehensive income (loss) (189) (189) Balance at May 31, 2014 178 $ 692 $ 3 $ 5,865 $ 85 $ 4,871 $ 10,824 Stock options exercised 14 639 639 Repurchase of Class B Common Stock (29) 19) (2.525) (2.534) Dividends on common stock ($1.08 per share) (931) (931) Issuance of shares to employees 2 92 92 Stock-based compensation (Note 11) 191 191 Forfeiture of shares from employees (5) (3) (8 Net Income 3,273 3.273 Other comprehensive income (loss) 1,161 1,161 Balance at May 31, 2015 178 $ 679 s 3 $ 6,773 $ 1,246 $ 4,685 $ 12,707 The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement FORM 10-K ) RIV numerical example with a constant growth rate Forecast years t=0 2001 2002 2003 2004 2005 EPS DPS 4.57 0.82 20.25 4.60 0.85 23.99 4.71 0.88 27.83 4.90 0.91 31.82 5.03 0.93 35.93 BPS 16.5 CV 1.91 2.92 0.9091 2.66 2.57 0.8264 2.12 2.31 0.7513 1.74 2.12 0.6830 1.45 1.85 0.6209 1.15 Residual Earnings Discount Factor PV of RE g=0.03 r=0.10. Opening BPS 16.50 Finite horizon RE 9.12 Continuing value 16.91 Inrtinsic Price 42.53 N.B. The XL Spreadsheet is on BB